Financial Justification of Technology

Instructor: Allison Tanner
New technologies can be highly beneficial to a company, but they come with a high price tag. This lesson will describe financial justification and provide examples of how a company can financially justify the purchase of new technology.

Update the Office?

John works for a successful marketing firm that has been in business for almost twenty years. Although business is great, John wants the company to consider purchasing new technology for tracking sales, potential clients, and follow-ups.

New technology can be extremely expensive and companies don't always feel comfortable investing large sums of money without a guarantee that it will be worth the expense. In John's case, the software costs almost $20,000, and his boss has been hesitant to purchase because their current system seems to work fine.

John really wants this new technology, so he decides he needs to explain, or financially justify, why the new technology is worth the initial expense.

Tools for Financial Justification

There are a variety of tools that can be used to financially justify the added cost of purchasing new technology. Each one attempts to explain the benefit of spending the money on new technology.

Total Capital Cost

The total capital cost is the initial cost that the company will have to pay to purchase the software and start using it effectively. For simplicity, let's say that John determines that the cost of installing the software and the training to use it is approximately $5,000.

This means:

Cost of the program = $20,000

Cost of installation and training = $5,000

Total Cost: = $25,000

Cost Benefit Analysis

Now that John knows the total cost he can do a cost benefit analysis. This tool measure the total expected benefit of the purchase and then divides it by the total cost. In doing so, it determines the expected profit that will come from purchasing the technology. Typically, a cost benefit analysis is done when a company knows the total cost of the new technology and the total benefit over the life of the technology.

John expects that by using the software, his firm will make $100,000 more than they would have without the program.

Using both of these numbers he can calculate the cost benefit ratio:

Total Benefit / Total Cost = ($100,000 / $25,000) = a 4:1 ratio

This means that for every dollar that his company spends, they expect to profit four dollars. Using this measure, John can show that in the long-run, the project is worthwhile.

Return on Investment

The return on investment provides a percentage which helps to explain how beneficial the cost of the new technology is and how effective it is at making the company more money.

This is measured by taking the Total Benefit - Total Cost, and then dividing it by the Total Cost.

(Total Benefit - Total Cost) / (Total Cost)

Using the same numbers from above John can calculate the return on investment.

($100,000 - $25,000) = $75,000

($75,000) / ($25,000) = 3 or 300%

This means the return on investment is 300 percent. Because a total of 1 would mean that John's company broke even or only made back the money they spent. This total of 3 means that John's company would be making more than what they spent on the program.

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